Nervous that a costly lawsuit could plague the firm’s operations and balance sheet, more GPs are looking to limit their fiduciary duties to investors, legal sources tell pfm.
Fiduciary duties exist to deter management from abusing their power over the funds’ property. In certain jurisdictions, such as Delaware, this protection can be waived in the operating agreement of limited partnerships and limited liability companies. GPs however would still be bound by an implied covenant of good faith and fair dealing when managing the partnership assets.
GPs that are able to negotiate a fiduciary duty carve-out will reduce the possible options investors have to sue for a breach of contract, said Marc Feinstein, litigation partner at law firm O’Melveny & Myers. In these instances a court would have to look at the specific terms of the agreement to determine what duties the investment manager has to the fund.
“Investors couldn’t sue for tortious conduct based on a claim for breach of fiduciary duty. And if you are only suing for breach of contract then your damages won’t include punitive damages; and if you can’t sue for fiduciary duty then you might not have some of the remedies available like disgorgement of profit.”
GPs are having to get savvier in protecting themselves from litigation as the amount of disputes in the private fund space, both in the US and internationally, has grown significantly in the last five years, added Tim Mungovan, co-head of the private investment funds disputes practice at law firm Proskauer.
One method GPs use to “chill” lawsuits is to withhold distributions, said Feinstein. “The investors are looking for distributions and so one of the ways the manager can dissuade or chill suits is that if an investor does bring a suit or threatens to then the manager will respond by saying it will have to set aside cash and withhold distributions to protect against any liability.”
For a more in-depth look at how GPs are protecting themselves against litigation, be sure to check out the October issue of pfm.